TCS Daily

Flat Tax Peak

The governing program of the
DA ("yes") Alliance, the center-right opposition in Romania contains an unprecedented proposal: a flat tax of 16
percent, for both corporate and income tax, coupled with lower compulsory
social contributions. Usually, when a party with the best chance to win the
parliamentary and presidential elections (scheduled for November 28) offers
such a daring proposal, it reflects a massive shift in preferences of the
electorate.

How is it that
such a change appeared in a country characterized by the slow pace at which it
has left communism behind? After the fall of communism, in December 1989, the
Social-Democratic party -inheriting the young wing of the former communist
party - adopted a progressive taxation system, based on four classical
brackets. However, in recent years, this system has become less and less
efficient, due to increases in taxation levels and widespread corruption. In
the years 2000-2004, the black and gray economy was constantly evaluated at 40
percent.

In real terms, this means
that most firms declare zero profit, to avoid taxation, preferring to distribute
the money through illegal operations. Often firms employ people with two
salaries: a declared (nominal) one, at the lowest level allowed by the law, and
a real one, usually two or three times higher. As long as this situation was
limited to the high-income level of the population, the bracket system was
defended by the social-democratic ideology of social justice based upon
comprehensive redistribution.

Nevertheless, constant
economic growth began to spread towards the urban low-income categories, and
especially toward the rural population, both of them being hardcore supporters
of the social-democrats. Thus, a 40 percent black market means that young
people moving from rural zones to cities, attracted by a better life, cannot
find white market jobs. They can only earn tax-avoiding wages, which cannot,
for example, offer access to highly attractive consumer credit. Furthermore,
two million Romanians, usually young people from rural areas, have gone abroad
to work in low-paid jobs across Europe.

Both these last categories
noticed that they do not want the stay-poor social protection offered by the
social democratic party. They became a furious category of free market voters,
furious that they were cheated with electoral social protection for 15 years,
and for another 50 years of communism before. They realized they want to be
paid fairly for their work, as in other countries, to be able to have a better
life, to get credit and to govern their own lives, without being patronized by
a corrupt state.

In fact, on June 6 this
year, local elections were held in Romania.
While the center-right never even hoped to win in rural areas or in poorer
parts like Moldavia,
something unbelievable happened: Young people who had gone abroad or to the
cities to work called home and told their families in the countryside to vote
with the Alliance
and to throw out the social-democratic government. In June, the Alliance
candidates won in remote places where no center-right wing candidate has won
before.

While this major shift in
preferences appeared, a few NGOs proposed the flat tax principle at the end of
2003. Immediately adopted by the opposition, the proposal was even supported by
the social democratic minister of finance. However, the hard-core, old-school
social democrats, grouped around President Iliescu, refused to accept the flat
tax, basing their opposition upon the classical social justice argument.

The Alliance built its whole political program, the
"Platform of Governing for Romania" on the base of the flat tax. Submitting a
macroeconomic projection of the flat tax's impact on the economy, it evaluated
the budgetary revenues and expenses based on a 16 percent tax on corporate
income. The main argument was simple: while the (nominal) taxation level is at
about 23-25 percent, due to evasion, the effective taxation rate is in fact 16
percent. So why not lower the nominal tax rate to match the real one, at 16
percent, thus enlarging the taxation base?

In recent televised debates
on the political programs of the two main forces, the Alliance
representative supported the flat tax, against the minister of finances
(representing the social-democrat party), who proposed some tax cuts through
lowering and simplifying the brackets system. As a former supporter of the flat
tax, the finance minister was in the uncomfortable position of defending
something he does not believe in. Although it was noted that the two candidates
won the prize for "most technical discussion ever on television", it
was the first time in Romania
that the Laffer argument was discussed outside academia.

That the flat tax is such a
major issue in the campaign reflects a profound change in the social structure
and preferences of the country. When a political force (i.e. the Alliance)
believes it can win votes with the revolutionary proposal of renouncing at the
progressive taxation, maybe Romania
has finally left communism behind.

The author is an advisor
to the Liberal Group, in the Romanian Chamber of Deputies.